4 Forecasting

PowerPoint presentation to accompany

Heizer and Render
Operations Management, 10e
Principles of Operations Management, 8e

PowerPoint slides by Jeff Heyl

© 2011 Pearson Education, Inc. publishing as Prentice Hall 4-1

 What is Forecasting?
 Process of predicting
a future event
 Underlying basis
of all business
??
decisions
 Production
 Inventory
 Personnel
 Facilities

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© 2011 Pearson Education, Inc. publishing as Prentice Hall 4-3
 Forecasting Time Horizons
 Long-range forecast (comprehensive)
 3+ years
 New product planning, facility location,
research and development
 Short-range forecast (more accurate)
 Up to 1 year, generally less than 3 months
 Purchasing, job scheduling, workforce
levels, job assignments, production levels
 Medium-range forecast
 3 months to 3 years
 Sales and production planning, budgeting
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 Influence of Product Life
Cycle
Introduction – Growth – Maturity – Decline

 Introduction and growth require longer

forecasts than maturity and decline
 As product passes through life cycle,
forecasts are useful in projecting
 Staffing levels
 Inventory levels
 Factory capacity

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 Strategy based on Product Life Cycle
Introduction Growth Maturity Decline
Product design Forecasting Standardization Little product
and critical Fewer product differentiation
development
Product and changes, more Cost
OM Strategy/Issues

critical
process minor changes minimization
Frequent reliability
Optimum Overcapacity
product and
Competitive capacity in the
process design
product industry
changes Increasing
improvements
stability of Prune line to
Short production and options process eliminate
runs
Increase capacity items not
Long production
High production returning
Shift toward runs
costs good margin
product focus Product
Limited models Reduce
Enhance improvement and
capacity
Attention to distribution cost cutting
quality

Figure 2.5
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 Seven Steps in Forecasting
1. Determine the use of the forecast
2. Select the items to be forecasted
3. Determine the time horizon of the
forecast
4. Select the forecasting model(s)
5. Gather the data
6. Make the forecast
7. Validate and implement results

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 The Realities!

 Forecasts are seldom perfect

 Most techniques assume an
underlying stability in the system
 Product family and aggregated
forecasts are more accurate than
individual product forecasts

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 Forecasting Approaches
1. Qualitative Methods

2. Quantitative Methods

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 Qualitative Methods

 Used when situation is vague

(radical) and little data exist
 New products
 New technology
 Involves intuition, experience

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 Qualitative Methods

1. Jury of executive opinion

 Pool opinions of high-level experts, Group
estimates demand by working together
2. Delphi method
 Panel of experts, queried iteratively
3. Sales force composite
4. Consumer Market Survey
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 Delphi Method
 Iterative group
Decision Makers
process, (Evaluate
continues until responses and
consensus is make decisions)
reached
Staff
 3 types of (Administering
survey)
participants
 Decision makers
 Staff Respondents
(People who can
 Respondents make valuable
judgments)
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 Quantitative Methods
 Used when situation is ‘stable’ and
historical data exist
 Existing products
 Current technology
 Involves mathematical techniques
 e.g., forecasting sales of color
televisions

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 Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
3. Exponential time-series
smoothing models
4. Trend projection
5. Seasonality
6. Linear regression associative
model
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 Time Series Forecasting

 Set of evenly spaced numerical data

 Obtained by observing response
variable at regular time periods
 Forecast based only on past values,
no other variables important
 Assumes that factors influencing
past and present will continue
influence in future

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 Time Series Components

Trend Cyclical

Seasonal Random

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 Components of Demand
Trend
component
Demand for product or service

Seasonal peaks

Actual demand
line

Average demand
over 4 years

Random variation
| | | |
1 2 3 4
Time (years)
Figure 4.1
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 Naive Approach
 Assumes demand in next
period is the same as
demand in most recent period
 e.g., If January sales were 68, then
February sales will be 68
 Sometimes cost effective and
efficient
 Can be good starting point

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 Moving Average Method

 MA is a series of arithmetic means

 Used if little or no trend
 Used often for smoothing
 Provides overall impression of data
over time

∑ demand in previous n periods

Moving average = n

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 Weighted Moving Average
 Used when some trend might be
present
 Older data usually less important
 Weights based on experience and
intuition
∑ (weight for period n)
Weighted x (demand in period n)
moving average = ∑ weights

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 Exponential Smoothing
 Form of weighted moving average
 Weights decline exponentially
 Most recent data weighted most
 Past forecast and Past actual
 Requires smoothing constant ()
 Ranges from 0 to 1
 Subjectively chosen
 Involves little record keeping of past data
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 Choosing 

The objective is to obtain the most

accurate forecast no matter the
technique
We generally do this by selecting the
model that gives us the lowest forecast
error

Forecast error = Actual demand - Forecast value

= At - Ft
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 Comparison of Forecast
Error
∑ |deviations|
Rounded Absolute Rounded Absolute
MADActual
= Forecast Deviation Forecast Deviation
Tonnage n
with for with for
Quarter Unloaded  = .10  = .10  = .50  = .50
1
For  =
180
.10 175 5.00 175 5.00
2 168 = 82.45/8
175.5 = 10.31
7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 For 175
= .50 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 = 98.62/8
175.02 = 12.33
29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62

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 Trend Projections
Fitting a trend line to historical data points
to project into the medium to long-range
Linear trends can be found using the least
squares technique

y^ = a + bx
^ where y = computed value of
the variable to be predicted
(dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable
If a and b are given, when X is 8, Y=?
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 Least Squares Example
Trend line,
160 –
150 –
y^ = 56.70 + 10.54x
140 –
Power demand

130 –
120 –
110 –
100 –
90 –
80 –
70 –
60
50
–
–
If X is 8 (year 2010), Y= 141.02
| | | | | | | | |
2003 2004 2005 2006 2007 2008 2009 2010 2011
Year
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 Seasonal Variations In Data
Steps in the process:
1. Find average historical demand for each season
2. Compute the average demand over all seasons
3. Compute a seasonal index for each season
4. Estimate next year’s total demand
5. Divide this estimate of total demand by the
number of seasons, then multiply it by the
seasonal index for that season

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 Associative (Regression)
Forecasting
Used when changes in one or more
independent variables (Cause) can be used to
predict the changes (Effect) in the dependent
variable
Most common technique is linear
regression analysis

We apply this technique just as we did

in the time series (Trend) example

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 Associative (Regression)
Forecasting
Forecasting an outcome based on predictor
variables using the least squares technique

y^ = a + bx
^ where y = computed value of
the variable to be predicted
(dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable
though to predict the value of the
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 Associative (Regression)
Example (a and b are given)
y^ = 1.75 + .25x Sales = 1.75 + .25(payroll)

If payroll next year

is estimated to be 4.0 –
$6 billion, then: 3.25

Nodel’s sales
3.0 –

Sales = 1.75 + .25(6) 2.0 –

Sales = $3,250,000
1.0 –
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll

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 Multiple Regression
Analysis
If more than one independent variable is to be
used in the model, linear regression can be
extended to multiple regression to
accommodate several independent variables
^y = a + b x + b x …
1 1 2 2

Computationally, this is quite

complex and generally done on the
computer
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 Multiple Regression
In the Nodel example, including interest rates in
the model gives the new equation:

^ = 1.80 + .30x - 5.0x

y 1 2

An improved correlation coefficient of r = .96

means this model does a better job of predicting
the change in construction sales
Income (X1) = 6, Interest rate (X2) = 0.12, Sales (Y)=?

Sales = 1.80 + .30(6) - 5.0(.12) = 3.00

Sales = $3,000,000
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 Correlation
 How strong is the linear
relationship between the variables?
 Correlation does not necessarily
imply causality!
 Coefficient of correlation, r,
measures degree of association
 Values range from -1 to +1

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 y
Correlation Coefficient y

(a) Perfect positive x (b) Positive x

correlation: correlation:
r = +1 0<r<1

y y

(c) No correlation: x (d) Perfect negative x

r=0 correlation:
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r = -1 4 - 35
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